Clorox: Reasonably Valued But Not Cheap Yet
- In a base case scenario, I see Clorox shares as fairly valued today.
- That said, there's a good argument for Clorox being able to turn margins around and get the business back on track by year-end 2024.
- I see a path to a $175 share price in 2024 if the company is able to stabilize its profit margins and get costs under control.
- The potential upside is not enough to get me to open a position today, however. I'd prefer an entry price in the $120s.
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After a big run-up in 2020, shares of Clorox (NYSE:CLX) have washed out completely. In fact, the cleaning products maker is now trading well below where it did prior to the start of the pandemic:
At first glance, this probably seems counterintuitive. After all, Clorox enjoyed a historic increase in earnings during 2020 as demand for cleaning products surged. After that initial period, people were fully stocked up at home, thus leading to a drop in sales momentum for the grocery channel since then. However, there has been elevated demand for sanitation and hygiene products in public spaces since 2020 as property owners take more aggressive measures against the potential spread of disease.
That being the case, you'd think Clorox would be, at the absolute worst, trading back at $160 where it was prior to Covid-19's onset. Instead, with the recent dip, CLX stock is below the $140 mark.
Clorox has plunged because its earnings have plummeted over the past 12 months. The company has been battered by rising costs on all fronts including commodity prices, manufacturing costs, and logistics expenses. It's all resulted in a shocking collapse in gross margins from 43.5% in 2021 to just 35.9% this past quarter. Normally, companies are fighting for 50 or 100 basis points of margin on a quarter-to-quarter; losing 760 basis points of margin year-over-year is almost incomprehensible.
Investors have understandably reacted by dumping the stock. But is this an overreaction? It all comes down to where earnings level out going forward.
Just How Much Money Can Clorox Regularly Earn?
The million dollar question for evaluating Clorox stock now is figuring out how much profits the company can consistently generate.
For reference, here are the company's annual earnings per share dating back to 2005:
As you can see, Clorox had generally enjoyed steady earnings growth, aside from one significant dip in 2011. In the early 2010s, earnings growth was plodding, to put it kindly. Things picked up significantly from 2016 and onward, however.
Of course, everything went into overdrive in 2020, with the company's trailing twelve month earnings jumping from $6 to nearly $10 at the worst moments of the pandemic. Since then, though, earnings have outright crashed. They didn't stop at the $6 pre-pandemic levels; instead they're down to just $3.57 over the past 12 months.
Analysts see this year being the trough, with earnings recovering slightly to $4.16 for full-year 2022, though that will still be a massive decline from 2021:
Going forward, however, as inflationary pressures start to lift, Clorox should be able to stabilize its profit margins and thus bring earnings back up to $5.52 in 2023 and $6.46 in 2024, according to the analyst consensus.
Recall that Clorox was making around $6.25 per share just prior to the pandemic. So, if the analysts are correct, Clorox will more or less get back to where it was in 2019 during 2024.
There is a more optimistic take though. If you believe Clorox's brand power and business quality is essentially the same as it was in 2019, there's reason to think the company could be significantly more profitable going forward than it was in 2019.
That's because the top-line sales growth has stuck. In 2019, Clorox did $6.2 billion in revenues. It's running roughly $7.1 billion of annual sales now. That's 15% top-line growth. And analysts see Clorox returning to additional revenue growth in 2023. The combination of additional demand and inflation has allowed Clorox to generate faster-than-usual revenue increases. By comparison, between 2012 and 2019, Clorox grew revenues just $800 million. Since 2019, however, it's grown revenues fully $900 million. That's significant acceleration.
Now if Clorox can get its profit margins back to 2019 levels, we're looking at meaningfully more profitability. Let's unpack the cost side a bit.
Between 2019 and now, the company's cost of sales increased $1.1 billion to generate those extra $900 million of revenues. That's why profits have plunged. Over time, Clorox should either be able to push through additional price increases or see the cost of inputs decline to more traditional levels. Also, Clorox boosted SG&A roughly 15% since the beginning of 2020, presumably to address the sudden increased product demand and logistical challenges presented by the pandemic. Some focus on cost control could iron out the extra costs on the SG&A front.
The Upside Scenario
For much of the past decade prior to 2020, Clorox traded at a healthy P/E ratio in the 23-27x range:
Let's say investors are willing to give Clorox a 25 multiple on its long-term earnings power. This assumes Clorox is able to fix its margin problems and that the market forgives the company for this uncharacteristically volatile period in its operations.
Based on 2024 expected revenues, with healthier 2019-level profit margins, Clorox could post $7 of earnings per share. A 25 P/E ratio on that would get to a $175 stock price versus the current $139 stock price. That's 26% share price upside over two years plus the 3.3% dividend yield. This is an attractive return on a blue chip consumer staples company such as Clorox.
CLX Stock Bottom Line
The issue with the above analysis is that I laid out the reasonably upbeat bullish scenario and it's still not all that compelling. For stepping into a messy situation such as Clorox's current earnings volatility, I'd like to get paid a little more for the risk.
The more neutral outlook would be that Clorox's 2024 earnings return to pre-pandemic levels of around $6.25 per share. At a 22x earnings multiple, reflecting the market's less favorable appraisal of the company's moat and business quality, we'd end up at a 2024 price target of $138. That'd result in the stock delivering no return between now and then aside from the dividend.
And while I don't put a high possibility on a downside scenario, there's also the possibility that inflation continues to run unchecked, causing Clorox's earnings to slide even further before starting to recover. In that case, CLX stock could slip significantly below fair value before turning the corner.
I'm not opposed to CLX stock here. Shares are reasonably valued. The dividend yield is certainly nice at 3.3% and I see little risk of a dividend cut.
However, even giving the company some reasonably upbeat assumptions, forward annual return expectations are only in the 15% or so range in a bull case over the next two years. I'd like to do a little better to get involved in a company undergoing so much current volatility and uncertainty.
This is the sort of name to either consider selling puts on to establish a position at a lower price, or put near the top of the watchlist. If shares dip into the $120s, that'd significantly improve the calculus for CLX stock going forward. As a big fan of the consumer staples sector, this is the sort of company I want to own at the right price. And given the massive amount of uncertainty in Clorox's short-term earnings outlook, the market may offer up an attractive entry point in coming months.
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This article was written by
Ian worked for Kerrisdale, a New York activist hedge fund, for three years, before moving to Latin America to pursue entrepreneurial opportunities there. His Ian's Insider Corner service provides live chat, model portfolios, full access and updates to his "IMF" portfolio, along with a weekly newsletter which expands on these topics.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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